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Readers of my columns know that one of the guiding principles of my trading is to follow short interest. In fact, one of my 10 Trading Commandments (No. 6, to be precise) is "Short sellers are usually a bull's best friend."
Why have I been so successful using short interest? It's all about the "squeeze" that happens when a heavily shorted stock starts to rise.
That's when short sellers are forced to "cover" their losing positions on a stock. This results in unusually strong buying volume that drives a stock price higher.
I filter the bi-weekly short interest data from the exchanges to identify stocks with unusually high short interest. What's unusual? My Best in Breed (BIB) model searches for short-interest ratios (short interest divided by the average daily trading volume) above 6.0.
In addition, the model searches for increasing short interest, indicating that the shorts are adding to their bets against the stock.
Today, my BIB model told me that biotech is the most heavily shorted sector in the market right now. In fact, the SPDR S&P Biotech ETF (XBI) is the only ETF with a double-digit weighted component short interest ratio.
The current ratio of 10.7 is rare among ETFs, so I drilled down on the sector to look at individual stocks that are contributing to the elevated short interest.
While there are several stocks with high short interest, I filtered the results for those in a strong technical uptrend as defined by trading above their rising 50-day moving averages.
My models show that the odds of a stock moving higher double when the 50-day moving average is trending higher.
It's this combination of high short interest (bearish sentiment) and bullish technical strength that creates a short squeeze situation and gives me the "best of the best" bullish stocks.
Running the filter produced two names that stood out, so let's take a look at each one…
About the Author
Chris Johnson is a highly regarded equity and options analyst who has spent much of his nearly 30-year market career designing and interpreting complex models to help investment firms transform millions of data points into impressive gains for clients.
At heart Chris is a quant - like the "rocket scientists" of investing - with a specialty in applying advanced mathematics like stochastic calculus, linear algebra, differential equations, and statistics to Wall Street's data-rich environment.
He began building his proprietary models in 1998, analyzing about 2,000 records per day. Today, that database, which Chris designed and coded from scratch, analyzes a staggering 700,000 records per day. It's the secret behind his track record.
Chris holds degrees in finance, statistics, and accounting. He worked as a licensed broker for 11 years before taking on the role of Director of Quantitative Analysis at a big-name equity and options research firm for eight years. He recently served as Director of Research of a Cleveland-based investment firm responsible for hundreds of millions in AUM. He is also the Founder/CIO of ETF Advisory Research Partners since 2007, noted for its groundbreaking work in Behavioral Valuation systems. Their research is widely read by leaders in the RIA business.
Chris is ranked in the top 99.3% of financial bloggers and top 98.6% of overall experts by TipRanks, the track record registry of financial analysts dating back to January 2009.
He is a frequent commentator on financial markets for CNBC, Fox, Bloomberg TV, and CBS Radio and has been featured in Barron's, USA Today, Newsweek, and The Wall Street Journal, and numerous books.
Today, Chris is the editor of Night Trader and Strikepoint Trader and contributes to Money Morning as the Quant Analysis Specialist.